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Taxation of the digital economy back on the international tax agenda

Gareth Bevan29 September 2017No comments

Over the past week both the European Commission and OECD have announced that they are looking to move forward on the issue of taxation of the digital economy.

The issues

The main issue centres around the fact that international tax rules are outdated and not designed for a digital world. The result is that there is an uneven playing field between the taxation of traditional “bricks and mortar” businesses and those operating in the digital economy.

In today’s digital world often no physical presence is required to sell goods and services into a market which means it is difficult to establish a tax base in the market’s jurisdiction which can be taxed. The result is that in many cases digitalised businesses, particularly those operating cross-border, can end up with a very low or zero tax burden.

In addition, digitalisation is leading to an increased blurring of the lines between goods and services, for example in the cases of e-books and 3D printing. Different VAT rules apply to goods and services meaning that items which a customer might view as essentially the same product, e.g. a physical book and an e-book, can be subject to different VAT treatment.

The European Commission Communication

The European Commission has issued a Communication to the European Parliament and the Council entitled “A Fair and Efficient Tax System in the European Union for the Digital Single Market”. In it the European Commission states that it is seeking to establish a strong and co-ordinated position amongst Member States on the matter in view of the lack of progress to date at the global level.

The Commission’s view is that the EU needs to ensure that profits generated in the EU from the digital economy are effectively taxed by EU Member States and redistributed fairly.

The Commission has identified the main policy challenges as being:

Nexus (where to tax) – how to establish and protect the taxing rights in a country where businesses can provide services digitally with little or no physical presence despite having a commercial presence

Value creation (what to tax) – how to attribute profit in new digitalised business models driven by intangible assets, data and knowledge.

The Commission acknowledges that the OECD’s interim report on the taxation of the digital economy which is due to be presented to G20 Finance Ministers in April 2018 is an important milestone. In the meantime, it considers that the EU should continue to look at options for new rules for taxing the digital economy within the Single Market, in case progress at the wider international level is too slow.

The Commission states that it believes its Common Consolidated Corporate Tax Base (CCCTB) proposal addresses the main challenges. In its view CCCTB provides an EU framework for revised permanent establishment rules and for allocating profits of large multinational groups using a formula apportionment approach based on assets, labour and sales that better reflects where value is created.

In the short-term other potential solutions include:

Equalisation tax on turnover of digitalised companies – A tax on all untaxed or insufficiently taxed income generated from all internet-based business activities, including business-to-business and business-to-consumer, creditable against the corporate income tax or as a separate tax

Withholding tax on digital transactions – A standalone gross-basis final withholding tax on certain payments made to non-resident providers of goods and services ordered online

Levy on revenues generated from the provision of digital services or advertising activity – A separate levy could be applied to all transactions concluded remotely with in-country customers where a non-resident entity has a significant economic presence.

The Commission concludes that in the absence of adequate global progress, EU solutions should be advanced within the Single Market and it will be ready to present the appropriate legislative proposals. The Commission will continue to analyse the policy options and consult with relevant stakeholders and industry representatives on the issue ahead of a possible proposal by Spring 2018.

At the same time the OECD has launched a request for public input on the tax challenges of digitalisation ahead of a public consultation meeting to be held in November 2017. It is inviting comments on a number of questions related to:

the impact of digitalisation on business models and value creation

challenges and opportunities for tax systems

the implementation of the measures outlined in the BEPS package and

potential options to address the direct tax challenges of digitalisation.

It is also seeking comments on a draft outline of its interim report for the G20 Finance Ministers.

The OECD announcement and links to the relevant documents can be viewed here.

Keep up to date with new developments

The issue of taxation of the digital economy is going to be one of the key developing areas of international tax law over the coming years. It is likely to lead to significant changes in the way many businesses are taxed. Businesses should carefully monitor developments on the issue as they could have a major impact on current business models.